Volex Plc: Half-year Report to 2 October 2016

11 November 2016

VOLEX plc

Half year results for the 26 weeks ended 2 October 2016

 'Strong cash flow generation returns the group to a net cash position'

Volex plc ('Volex'), the global provider of cable assemblies, today announces its interim results for the 26 weeks to 2 October 2016 ('H1 FY2017').

* Before non-recurring items and share-based payments

Financial highlights

·     $11.3 million of cash generated by operations through tight working capital management returns the Group to net cash at period end.

·     Underlying operating profit is up 2.3% on H1 FY2016 despite a 12.3% reduction in sales.

·     The revenue decline from our largest customer (21.7% decline) has been managed by a reduction in our Power manufacturing footprint.  This has resulted in a non-cash impairment charge of $6.2 million.

·     Underlying operating expenses for the half year have reduced by $3.6 million or 13.5% as the benefits from removing the divisional management structure in the prior year and further cost reduction measures taken in the first half of 2016 are observed. 

·     A $4.6 million statutory operating loss after tax was recorded (after the $6.2 million impairment charge and $1.1 million of non-recurring costs associated with the down-sizing of the Brazilian operation).

·     US facility successfully exited and 50% size reduction in our Singapore head office.    

·     Underlying diluted EPS up 60% to 2.5c following a reduction in the global tax charge.

·      Basic loss per share of 7.5c recorded reflecting the impairment charge taken in the half year.

Nat Rothschild, Executive Chairman, said:

"I am pleased to report that underlying profitability has been maintained at prior year levels reflecting the actions that we have taken to address the continuing decline in revenues from several of our larger customers.  

There has been strong progress at the factory level with improvements in operational efficiency and reductions in inventories and factory operating expenses.  Through the difficult actions we have taken in the first half of the year, which have included the downsizing of one of our Chinese facilities and the closure of our Brazil facility, factory profitability should improve in the second half of the year as we run at higher capacity with lower overheads.

Furthermore, work at our previously announced joint venture agreement with a Taiwanese manufacturer continues with the aim of producing competitively priced Volex-branded AC raw cables.  We hope to benefit from this arrangement in the next financial year.

We have an encouraging set of projects in the sales pipeline, however, we anticipate that the benefits arising from these will not be realised for at least another twelve months (the lead time to bring on new accounts).  In the meantime, we expect our markets to remain fiercely competitive and we will continue the practice of ensuring our factory footprint and costs are aligned with revenue performance".  

For further information please contact:

Volex plc

Nathaniel Rothschild, Group Executive Chairman                                 +65 6788 7833

Daren Morris, Group Chief Financial Officer                                             +44 208 017 3240

RESULTS FOR THE 26 WEEKS ENDED 2 OCTOBER 2016

Introduction

The Board is pleased to report its results for the half year to 2 October 2016 which has seen the Group maintain its underlying profitability despite a 12 % reduction in sales.  The significant cost reduction measures taken late last year (which included the removal of the divisional management teams), the ongoing rigorous cost control and favourable foreign exchange rate movements have all helped to offset the lost profit contribution from lower sales. 

Of the $23.3 million Group revenue reduction to $166.1 million, a significant proportion (circa 42%) can be attributed to our largest customer.  Our reliance on this customer has lessened somewhat in H1 FY2017 with their contribution to group revenue reducing from 26% in FY2016 to 21% in the current half year.  This revenue concentration has long been identified as a risk to Volex, however, we would expect the risk to reduce in the future as the account is expected to decline further over the next few years.  The continuing contraction of the PC market and product miniaturisation (leading to more power devices which can be charged with a USB cord and a power adapter rather than a conventional powercord) will further reduce demand and hence the need to diversify our customer base through on-boarding new customers and growing other accounts. 

This revision of our sales strategy from that of focusing on our large existing customers to targeting new accounts has resulted in personnel changes within our sales function.  With the on-boarding of new customers typically taking between 12 and 18 months, the full impact of the new strategy is not expected until next year.  However, the Group has reason to be encouraged about multiple new opportunities within its sales pipeline.

In the first half of the year, the Group has reacted to the revenue reduction by further reducing its cost base.  The significant actions taken last year (which included not only the removal of the divisional management teams but also the down-sizing of the Board, consolidation of executive management roles, removal of both direct and indirect labour heads at our factories and a significant down-sizing of our Brazilian facility) enabled the Group to report a modest increase to underlying operating profit for H1 FY2017, however, due to the continued contraction the following actions have also been taken:

·     Significant (33%) reduction in size to our largest factory site in China servicing the Power division's largest customer;

·     Closure of our Brazil factory until such time as the Brazilian economy recovers;

·     Closure of a number of our regional sales offices with sales responsibilities transferred either to other sales offices or to the factories themselves;

·     Commenced a review of our stock-holding hub network in Asia with a view to consolidating hub locations.  In the first half, 3 hubs have been closed with further opportunities identified in the second; and

·     Closure of a US facility and a 50% reduction in the size of our Singapore headquarters.

The impact of all of the above has been to reduce underlying fixed costs by $3.5 million in the half year.

Furthermore the manufacturing optimisation reviews taking place in each of the factories has helped improve the underlying gross margin despite the deleveraging effect of lower volumes passing through certain factories.  As presented within the FY2016 year-end accounts, our Mexico facility had been chosen as the pilot site in which all aspects of the production process are being reviewed and improved.  During H1 FY2017 this project has continued as well as being extended to all of our other facilities.  The tangible benefit of this factory focus can be seen in the slight margin improvement from 16.7% in H1 FY2016 to 16.9% in H1 FY2017 despite the 12.3% reduction in sales.      

The reduction in Power revenue and subsequent downsizing of Power's largest Chinese facility resulted in a fixed asset impairment charge of $6.2 million during H1 FY2017.  A further charge of $1.1 million was incurred in relation to the closure of the Brazil factory.  Combined with other one-off costs, a total non-recurring charge of $8.7 million was recorded in the half year.  As a result a statutory operating loss of $4.6 million is reported for the half year versus a statutory operating profit of $3.9 million in the same period last year.  

Further detailed analysis of the trading divisions is given on the subsequent pages. 

Trading performance

Power Cords Division

*According to H1 FY2016 revenue distribution

Volex designs and manufactures power cords, duck heads and related products that are sold to the manufacturers of a broad range of electrical and electronic devices and appliances.  Volex products are used in laptops, PCs, tablets, printers, TVs, games consoles, power tools, kitchen appliances and vacuum cleaners. 

The Power division revenue for H1 FY2017 was $100.4 million, down 14.5% on the prior period.  This downturn was observed across nearly the entire customer base and reflected further softening in Volex's core end markets as well as the impact of competing technologies and intense competition. 

The global PC market continues to shrink with global shipments in the period April to September 2016 down 5% on the corresponding period in the prior year.  This decline has been attributed to further market cannibalisation by the smartphone and a strong USD.  Similarly the global PC hardware peripherals market has contracted with a 7% reduction in shipments (for the period January to June 2016).  Our largest customer has seen its tablet sales volume reduce by 5% year on year and its laptop sales reduce by 13%. 

In addition to the contraction of the PC and PC peripherals end markets, a significant revenue decline was also observed from customers manufacturing household cleaning appliances.  As battery technology has improved, the need for retractable power cables is declining with vacuum manufacturers instead favouring a charging station for their unit.  Whilst this charging station still requires a power cable, its greater simplicity and shorter length means that the value of the cable is significantly reduced. 

Falling PC sales and the move to cordless household products are just two factors that have led to a reduction in the size of Volex's end markets.  Consequently competition has continued to intensify. For Volex to be successful, it must compete aggressively on price with every dollar saved from the production and procurement processes helping protect already thin margins.  Volex has the capability to compete - during the first half the sales team has successfully grown business with a well-known branded coffee capsule machine manufacturer such that it now represents a significant revenue stream.

However, for significant improvements in divisional profitability, the Power division needs to improve utilisation in its factories. Volex is therefore seeking new end markets in which Volex's expert knowledge in the manufacture of high power distribution cables and its reputation for quality and safety are best recognised.  In this regard, the first shipment of vehicle charging cables to a key manufacturer of electric cars, due in the second half of the year, represents an exciting development for Volex.   With forecasts predicting electric vehicles could make up to 35% of global new car sales by 2040, and with each of these requiring a sizeable power cable, the opportunity for Volex is significant.

The underlying Power gross profit has reduced to $14.2 million from $15.2 million in H1 FY2016, representing a gross margin of 14.2% (H1 FY2016: 13.0%).  The principal reason for the improvement in gross margin is a more favourable product mix.  Actions taken to reduce costs include:

·     Transferring a proportion of PVC production from the largest facility in China, Shenzhen, to Zhongshan (another Power factory in China) and Batam (Power factory in Indonesia).  This allowed Volex to downsize Shenzhen and focus a larger proportion of its production on its largest customer.  Zhongshan and Batam enjoy lower labour costs and should further benefit from economies of scale as greater PVC cable volumes pass through these factories; 

·     Continuing the alternate procurement sourcing programme in which a new cable supplier was integrated into the supply chain, reducing certain cable costs by 3%;

·     Extending the manufacturing optimization reviews to each of the Power factories.  By analysing the production processes, both direct and indirect headcounts have been reduced; and

·     Closure of a number of our sales offices and warehousing hubs. 

In addition to the above, Volex announced in H1 FY2017 it was to enter into a joint venture agreement with a Taiwan-based manufacturer, Joinsoon Electronics Mfg. Co. Ltd to engage in the development, manufacture and marketing of Volex-branded AC raw cables.  The impact of the joint venture on the Volex cost structure is not expected until FY2018 with work on the safety certification set to commence in November 2016 following the on schedule receipt in the first half year of all required business licences.

Operating costs have reduced by $1.1 million to $12.8 million following the actions taken in FY2016 to remove the Power divisional management team. 

Given the decline in Power revenues and the downsizing of the Shenzhen facility, the fixed asset base of Shenzhen was reviewed for potential impairment during the half year.  Writing off now redundant machinery acquired over the past ten years and aligning the remaining book value with the forecast profitability from the Shenzhen Power business has resulted in a non-cash impairment charge of $6.2 million in the period.  This has been reported as a non-recurring item.

Cable Assemblies Division

*According to H1 FY2016 revenue distribution

Volex designs and manufactures a broad range of cables and connectors (ranging from high speed copper and fiber-optic cables to complex customised optical cable assemblies) that transfer electronic, radio-frequency and optical data. Volex products are used in a variety of applications including data networking equipment, data centres, wireless base stations and cell site installations, mobile computing devices, medical equipment, factory automation, vehicle telematics, agricultural equipment and alternative energy generation.

Revenue for H1 FY2017 was $65.7 million, down 8.8% on the prior period but in line with H2 FY2016.  Revenue from the largest Data customer, operating in the Healthcare sector, was actually up 13.8% due to their strategy to consolidate a fragmented supply chain, with Volex benefiting from this effect.  However, this growth was off-set by a fall in sales to a leading legacy mobile telecommunications customer which continues to see its market share decline and a fall in sales to our largest transportation customer which is suffering from a cyclical drop in truck sales (US truck sales for the period April to August 2016 are down 15% on the prior year).

The revenue from the remaining customers fell by 6.1% to $28.1 million reflecting an over reliance on legacy business which Volex has been slow to address, such as internal cables used in PC's (significantly down) and household appliances (increased competition).  Revenue growth was observed in our Data Centre, Industrial and Medical Robotic end markets both of which place a premium on reliability and signal integrity.  Future sales projects currently within the pipeline are encouraging and include awarded business such as wiring harnesses for a commercial food service equipment manufacturer and data cables for an acoustic headset producer.    

The underlying gross profit has reduced to $13.8 million from $16.4 million, representing a gross margin of 21.0% (H1 FY2016: 22.8%).  This fall in margin reflects lost sales of complex cable harnesses on which a higher premium can be charged plus the deleveraging effect of passing fewer cables through the factories to absorb the fixed overheads.   

Operating costs have reduced by $1.9 million to $9.0 million.  This saving is primarily in headcount with activities taken in the second half of FY 2016 to remove the divisional management team reducing the cost base. 

As a result of the above, underlying divisional operating profit for the period fell from $5.5 million in H1 FY2016 to $4.8 million in H1 FY2017.

Despite the restructuring efforts made to our Brazilian operation in FY2016, it continued to generate losses in the first half of FY2017.  With little improvement forecast in either the Brazilian economy or the factory outlook, the tough decision was taken to suspend local operations.  A non-recurring charge of $1.1 million has been recognised in respect of the closure of the factory. 

Non-recurring items and share-based payments

Non-recurring items of $8.7 million have been incurred in the current period of which $6.2 million relates to the non-cash impairment of Power assets following the downturn in sales from our largest customer and downsizing of facilities (see Power discussion above) and $1.1 million relates to the closure of our Brazil operations (see Data discussion above).  A further $0.6 million was incurred in relation to severance payments arising from the downsizing of functions and facilities across the Group.

Following his appointment in November 2015, the Executive Chairman sought to address the production issues facing our factories across the globe in order to make them more cost competitive.  To support the management function, an external manufacturing consultancy was employed, to advise on manufacturing best practice and implementation.  These consultants will complete their work in December 2016 and the cost has therefore been classified as non-recurring. 

During H1 FY2017, the Group finalised the sub-let of its US facility incurring a cost of $0.3 million.  The sub-lease mirrors the head lease terms through to lease expiry with the exception of a quarter's rent free period included within the provision made. 

The prior year $1.1 million restructuring charge included $0.3 million for the departure of Christoph Eisenhardt (the former Chief Executive Officer), $0.4 million for the restructuring of the Power management team and $0.3 million for the right-sizing of our Brazilian operation.

The total cost of the former CEO's divisionalisation strategy, as well as the compensation of his management team, coupled with severances payments between FY2014 and FY2016 is estimated at $12.5 million.

In the prior year, off-setting the non-recurring charge was a $0.9 million credit for share-based payments arising from lapsed share options following the departure of certain employees. The current year charge of $0.1 million does not benefit from any similar lapses.

Tax

The Group incurred a tax charge of $1.1 million (H1 FY2016: $2.0 million). The underlying tax charge was $1.1 million (H1 FY2016: $2.0 million), representing an underlying effective tax rate of 32% (H1 FY2016: 60%), consistent with our expectation of the underlying ETR for the full year.

The reduction in the ETR reflects the work the Group has done to update its taxation of related party transactions and the tax effects of structural changes made within the Group over the past six months. 

Half year position and cash flows

Balance sheet and refinancing

Net assets as at H1 FY2017 are $45.2 million, down $6.1 million from the prior year end.  This is primarily due to the $6.2 million impairment booked against the fixed assets of the Power business (see Power discussion above). 

The $1.8 million increase to the UK defined benefit pension provision (arising from the reduction in UK government gilts) is off-set by the $2.2 million translation gain arising from converting the UK held liabilities into USD for presentation purposes post Brexit.  

A $2.5 million reduction in provisions is observed, primarily due to the utilisation of the UK property provision held at prior year end.  During H1 FY2017, a $2.5 million exit payment was made to release Volex from all of its obligations under the old UK head office lease.  This lease ran to March 2020 with future payments totalling $4.8 million.

The Group was in a net cash position of $5.2 million at H1 FY2017, an improvement of $8.4 million versus prior year end.  As reported in the year end accounts, in June 2016 the Group obtained a one year extension on its senior credit facility which now runs to June 2018.  $0.6 million of costs were incurred in arranging this extension, all of which have been capitalised and are being amortised over the period to June 2018.

Cash flows

The underlying business generated $13.3 million from its operating activities (H1 FY2016: $0.6 million), with the improvement on prior year primarily as a result of better stock control.  In addition, a further $4.2 million (H1 FY2016: $1.9 million) of non-recurring operational cash spend was incurred, including the $2.5 million UK onerous lease exit payment noted above. 

$1.0 million of capital expenditure was incurred on tooling and machinery throughout the Group, down $3.5 million on the prior period, reflecting the heavy investment in the prior year on new product roll-outs.

Outlook

Volex's core markets are expected to remain highly competitive in the near term with second half revenues forecast to be marginally below that achieved in the first half. 

Our focus for the coming year will continue to be on profitability and cash generation to further cement the foundation for the future. The strong progress achieved in the first half of the year to generate a greater return from our asset base through improved operational efficiencies and supply chain management will continue.

We will continue to prioritise growth in strategic sectors, such as Medical Robotics, over commodity volume business. Within the Industrial market we are identifying and focusing on attractive segments, such as the electric charger market, an area with high potential, which plays to our strengths.

As we build on the progress made in the first half, we are in a better position to win new business. However, the cost base and factory footprint of the Group will be closely monitored to ensure they remain aligned with revenue performance.

Risks and uncertainties

Risks to Volex are anticipated and regularly assessed and internal controls are enhanced where necessary to ensure that such risks are appropriately mitigated. The principal risks and uncertainties facing the Group in the second half of the year remain those detailed in the FY2016 Annual Report and Accounts on pages 17 to 18, a copy of which is available on the website at www.volex.com.

The principal risks and uncertainties are summarised as:

·     Competition and pricing pressure;

·     Sales Channel Effectiveness;

·     Customer concentration;

·     Supplier dependency;

·     Quality and product failure;

·     Key personnel retention;

·     Breach of financial covenants and liquidity;

·     Copper price volatility; and

·     Compliance with legislation and regulations.

Two further risks identified by the Board in the half year period are the impact of disruptive technologies such as improving batteries, wireless technology and USB-C and the exposure to foreign currencies.  To help mitigate the first risk, Volex has split its engineering function into a traditional in-house function which helps identify new opportunities and threats and determines how Volex best responds to them and a "field application engineering" function which embeds itself into key customers and keeps Volex abreast of customer specific issues.  Further the sales function is incentivised to identify new opportunities that are aligned with Volex's key strengths in high power distribution cables and rapid data transmission with reliable signal integrity.  In order to mitigate the second risk, the Volex central finance function closely monitors the exposure to key currencies such as the Chinese Renminbi and Mexican Peso and hedges these currencies where appropriate.

Responsibility statement

We confirm that to the best of our knowledge:

·     the condensed set of financial statements has been prepared in accordance with IAS34 'Interim Financial Reporting' as adopted by the EU.

·     the interim management report includes a fair review of the information required by DTR 4.2.7R:

o  an indication of important events that have occurred during the first six months of the financial year, and their impact on the condensed set of financial statements, and

o  a description of the principal risks and uncertainties for the remaining six months of the year.

·     the interim management report includes a fair review of the information required by DTR 4.2.8R:

o  related parties transactions that have taken place in the first six months of the current financial year and that have materially affected the financial position or performance of the Group in that period, and

o  any changes in the related parties transactions described in the Annual Report 2016 that could have a material effect on the financial position or performance of the Group in the current period.

Nathaniel Rothschild                                                                       Daren Morris

Executive Chairman                                                                         Group Chief Financial Officer

11 November 2016                                                                            11 November 2016

Unaudited consolidated income statement                                        

For the 26 weeks ended 2 October 2016 (26 weeks ended 4 October 2015)

Unaudited consolidated statement of comprehensive income  

For the 26 weeks ended 2 October 2016 (26 weeks ended 4 October 2015)

Unaudited consolidated statement of financial position                              

As at 2 October 2016 (4 October 2015)

Unaudited Consolidated Statement of Changes in Equity

For the 26 weeks ended 2 October 2016 (26 weeks ended 4 October 2015)